Notes to Consolidated Financial Statements

NOTE 13

INCOME TAXES

The components of Income before provision for income taxes, Discontinued operations, Extraordinary item and Cumulative effect of accounting change are as follows:

(dollars in millions)

Years Ended December 31,

2009

 

2008

 

2007

 

Domestic

$

10,673

 

$

14,993

 

$

13,561

 

Foreign

 

895

 

 

921

 

 

984

 

 

$

11,568

 

$

15,914

 

$

14,545

 

The components of the provision for income taxes from continuing operations are as follows:

(dollars in millions)

Years Ended December 31,

2009

 

2008

 

2007

 

Current

 

 

 

 

 

 

 

 

 

Federal

$

(611

)

$

365

 

$

2,568

 

Foreign

 

73

 

 

240

 

 

461

 

State and Local

 

364

 

 

543

 

 

545

 

 

 

(174

)

 

1,148

 

 

3,574

 

Deferred

 

 

 

 

 

 

 

 

 

Federal

 

1,085

 

 

2,214

 

 

397

 

Foreign

 

(35

)

 

(91

)

 

66

 

State and Local

 

340

 

 

66

 

 

(48

)

 

 

1,390

 

 

2,189

 

 

415

 

Investment tax credits

 

(6

)

 

(6

)

 

(7

)

Total income tax expense

$

1,210

 

$

3,331

 

$

3,982

 

The following table shows the principal reasons for the difference between the effective income tax rate and the statutory federal income tax rate:

Years Ended December 31,

2009

 

2008

 

2007

 

Statutory federal income tax rate

 

35.0

%

 

35.0

%

 

35.0

%

State and local income tax rate, net of federal tax benefits

 

0.8

 

 

2.5

 

 

2.2

 

Distributions from foreign investments

 

 

 

(0.4

)

 

3.9

 

Equity in earnings from unconsolidated businesses

 

(1.9

)

 

(1.4

)

 

(1.5

)

Noncontrolling interest

 

(18.7

)

 

(12.3

)

 

(11.0

)

Other, net

 

(4.7

)

 

(2.5

)

 

(1.2

)

Effective income tax rate

 

10.5

%

 

20.9

%

 

27.4

%

The effective income tax rate in 2009 decreased to 10.5% from 20.9% in 2008. The decrease was primarily driven by higher earnings attributable to the noncontrolling interest, which accounted for an 18.7 percentage point reduction in the effective tax rate in 2009 compared to a 12.3 percentage point reduction in 2008. Included within the (4.7)% ‘Other, net’ above is the impact of lower federal taxes, net of higher state taxes attributable to prior year adjustments to tax balances that were not material to the overall effective income tax rate.

The state and local income tax rate, net of federal tax benefits, in 2009 decreased to 0.8% from 2.5% in 2008 due to reductions in unrecognized tax benefits after statutes of limitations in multiple jurisdictions lapsed and the impact of earnings attributable to the noncontrolling interest.

The effective income tax rate in 2008 decreased to 20.9% from 27.4% in 2007. The decrease was primarily due to recording $610 million of foreign and domestic taxes and expenses in 2007 relating to our share of Vodafone Omnitel’s distributable earnings. This expense, which increased the effective tax rate by 3.9 percentage points in 2007 compared to 2008, was primarily comprised of $300 million of Italian withholding taxes and $260 million of U.S. federal income taxes. Verizon received net distributions from Vodafone Omnitel in April 2008 and December 2007 of approximately $670 million and $2,100 million, respectively.

The state and local income tax rate, net of federal tax benefits, in 2008 increased to 2.5% from 2.2% in 2007. The increase was primarily due to an increase in earnings at Verizon Wireless, apportioned to states with higher state income tax rates than the remainder of the Company’s operations. This increase was partially offset by lower expenses recorded for unrecognized tax benefits in 2008 compared to 2007. In addition, overall state income taxes in 2007 was also positively impacted by the lower tax rate applicable to earnings from its investments in unconsolidated businesses. Specifically, the Company disposed of its interest in CANTV in the second quarter of 2007, and as a result, the positive impact of the CANTV earnings was reduced in 2007 and eliminated in 2008.

Deferred taxes arise because of differences in the book and tax bases of certain assets and liabilities. Significant components of deferred tax are shown in the following table:

(dollars in millions)

At December 31,

2009

 

2008

 

Employee benefits

$

13,204

 

$

13,174

 

Tax loss and credit carry forwards

 

2,786

 

 

2,634

 

Uncollectible accounts receivable

 

303

 

 

341

 

Other – assets

 

1,269

 

 

953

 

 

 

17,562

 

 

17,102

 

Valuation allowances

 

(2,942

)

 

(2,995

)

Deferred tax assets

 

14,620

 

 

14,107

 

 

 

 

 

 

 

 

Former MCI intercompany accounts receivable basis difference

 

1,633

 

 

1,818

 

Depreciation

 

10,416

 

 

8,157

 

Leasing activity

 

2,081

 

 

2,218

 

Wireless joint venture including wireless licenses

 

18,249

 

 

12,957

 

Other – liabilities

 

1,012

 

 

823

 

Deferred tax liabilities

 

33,391

 

 

25,973

 

Net deferred tax liability

$

18,771

 

$

11,866

 

Employee benefits deferred tax assets include $9,161 million and $10,344 million at December 31, 2009 and 2008, respectively, recognized in accordance with the accounting standard relating to an employer’s accounting for defined benefit pension and other postretirement benefit plans (see Note 12).

At December 31, 2009, undistributed earnings of our foreign subsidiaries indefinitely invested outside of the United States amounted to approximately $1,100 million. We have not provided deferred taxes on these earnings because we intend that they will remain indefinitely invested outside of the United States. Determination of the amount of unrecognized deferred taxes related to these undistributed earnings is not practical.

At December 31, 2009, we had net tax loss and credit carry forwards (tax effected) for income tax purposes of approximately $3,300 million. Of these net tax loss and credit carry forwards (tax effected), approximately $2,600 million will expire between 2010 and 2029 and approximately $700 million may be carried forward indefinitely. The amount of net tax loss and credit carry forwards (tax effected) reflected as a deferred tax asset above has been reduced by approximately $639 million and $614 million at December 31, 2009 and 2008, respectively, due to federal and state tax law limitations on utilization of net operating losses.

During 2009, the valuation allowance decreased $53 million. The balance at December 31, 2009 is primarily related to state and foreign tax losses and credit carry forwards. Beginning January 1, 2009, we adopted the new accounting standard relating to business combinations. Due to the adoption of this standard, the reversal of valuation allowances associated with acquired losses recognized during 2009 was reflected in income tax expense.

Unrecognized Tax Benefits

A reconciliation of the beginning and ending balance of unrecognized tax benefits is as follows:

(dollars in millions)

 

2009

 

2008

 

2007

 

Balance at January 1,

$

2,622

 

$

2,883

 

$

2,958

 

Additions based on tax positions related to the current year

 

288

 

 

251

 

 

141

 

Additions for tax positions of prior years

 

1,128

 

 

344

 

 

291

 

Reductions for tax positions of prior years

 

(477

)

 

(651

)

 

(420

)

Settlements

 

(27

)

 

(126

)

 

(11

)

Lapses of statutes of limitations

 

(134

)

 

(79

)

 

(76

)

Balance at December 31,

$

3,400

 

$

2,622

 

$

2,883

 

Included in the total unrecognized tax benefits at December 31, 2009, 2008 and 2007 is $2,099 million, $1,631 million and $1,245 million, respectively, that if recognized, would favorably affect the effective income tax rate.

We recognize any interest and penalties accrued related to unrecognized tax benefits in income tax expense. During 2009 and 2008, we recognized a net after tax benefit in the income statement related to interest and penalties of approximately $14 million and $55 million respectively. During 2007, we recognized a net after tax expense in the income statement related to interest and penalties of approximately $175 million. We had approximately $552 million (after-tax) and $538 million (after-tax) for the payment of interest and penalties accrued in the balance sheets at December 31, 2009 and December 31, 2008, respectively.

The increase in unrecognized tax benefits during 2009 was primarily due to the acquisition of Alltel, from the filing of a refund claim related to non-U.S. income taxes, and increased unrecognized tax benefits related to non-U.S. income tax audits, partially offset by the resolution of certain U.S. income tax examinations.

Verizon and/or its subsidiaries file income tax returns in the U.S. federal jurisdiction, and various state, local and foreign jurisdictions. The Internal Revenue Service (IRS) is currently examining the Company’s U.S. income tax returns for the years 2004 through 2006. As a large taxpayer, we are under continual audit by the IRS and multiple state and foreign jurisdictions on numerous open tax positions. Significant foreign examinations are ongoing in Canada, Australia and Italy for tax years as early as 2002. It is reasonably possible that the amount of the remaining liability for unrecognized tax benefits could change by a significant amount during the next twelve-month period. An estimate of the range of the possible change cannot be made until issues are further developed or examinations close.